That certainly did not take them long. ElcomSoft, a Russian company, managed to crack the iOS4 encryption. With Apple's iPhone 3GS, the company introduced a hardware encryption chip. Following the release of iOS 4, Apple brought Data Protection feature, a 256-bit hardware encryption for all the devices featuring the chip, which is also why your device feels (and is) slower after the iOS 4 update. The…

…press release of the company states:

"ElcomSoft Co. Ltd. enables enhanced and near-instant forensic access to encrypted information stored in iPhone devices, and updates Elcomsoft Phone Password Breaker with tools that can access protected file system dumps extracted from iPhone devices, even if the data is hardware encrypted by iOS 4.

While iPhone backups store a lot of information about the usage of an iPhone device, they don't have everything. Forensic wise, dumping the contents of the physical device is the only proper way to handle an investigation. A decrypted dump of the file system can be analyzed by certified, highly advanced forensic tools."

You should not be worried about your data's safety though, unless you are planning to do something illegal and getting arrested. As it is clearly mentioned in the press release, a forensics expert needs to get a hold of the device itself in order to retrieve any data.